Own the Fed, Part XIV: Happy Days

While often viewed as the highpoint (and hidebound) pinnacle of "traditional" American culture and civilization, the 1950s were actually a time of revolutionary upheaval, politically, culturally, and, especially, economically. When we talk about the decade of the fifties as revolutionary, however, we are not referring to the "lost" or the "beat" generations. Vocal as they were, these were only a fringe element that did not define American life or culture.

The true revolution of the 1950s was the fundamental change in the attitudes of ordinary people. The presumed ideal of the nuclear family with two point whatever children, Father Knows Best, a wage system job as the primary source of family income, a car in every garage and a chicken in every pot, were, despite the common opinion, very recent innovations. This is especially true of the idea of a wage system job firmly ensconced within a monolithic capitalist economy as the sole source of income for the family.

Much of this sea change came out of the New Deal and had been formalized by the demands of the war. We may — if we wish or if we find it useful — denigrate the narrow-mindedness and so on that presumably characterized life in the 1950s. Such comments and the endless analyses of that time from that standpoint, however, always seem to miss the most revolutionary change of all: the switch from independence to dependence as the predominant condition of the "typical" American.

The basic problem was that the financial system and the economy were and remain essentially socialist — if we define socialism correctly as the abolition of private property in the means of production. As Karl Marx quite accurately pointed out in The Communist Manifesto, the communist revolution did not depend on abolishing private property for ordinary working people. Capitalism had already done that by concentrating ownership of the means of production in a small private elite and forcing the great mass of people into the wage system.

What the communists proposed was to establish justice by taking ownership of the means of production away from that small private elite, and concentrating ownership even further in the hands of the State. For most people, the United States in the 1950s, although it was called "capitalist," was to all intents and purposes socialist. There was and remains little difference between capitalism and socialism for the typical wage worker.

Whether capitalist, socialist, or some variation on those two themes, largely as a result of the New Deal and the reorientation of the Federal Reserve to conform to the tenets of the Currency School, virtually everyone now looked to the State to solve all problems. The McCarthy hearings were shocking not only for the methodology used, but the fact that, all things considered, both "capitalists" and "communists" used the same techniques, depending on who was able to seize power. The end justified the means, and the justice of the end was now determined by whoever managed to control the State.

This new orientation and understanding of the role of the State was demonstrated most graphically by the "Accord" reached under President Truman between the United States Treasury and the Federal Reserve System. This 1951 agreement ostensibly restored the independence of the Federal Reserve, but this — as required by the dictates of Keynesian monetary and fiscal policy — was independence in name only.

In addition to the essentially meaningless Accord between the Treasury and the Federal Reserve, however, a critical piece of legislation was passed to curtail certain abuses that continued to afflict the financial system. Bank holding companies were being used to circumvent prohibitions that had been implemented after the Panic of 1907 to prevent banks from owning non-banking businesses. There were also problems with bank holding companies acquiring banks and non-banking businesses across state lines.

To stop these abuses, Congress passed the Bank Holding Company Act of 1956 (12 U.S.C. § 1841, et seq.) to regulate bank holding companies. Bank holding companies had not been specified in previous legislation. Under the provisions of the new Act, the Federal Reserve Board of Governors now had to approve the establishment of any bank holding company. No bank holding company in one state could acquire a bank in another state. Bank holding companies were prohibited from engaging in virtually all non-banking activities, or from acquiring voting shares of certain types of non-bank businesses.

Despite the ineffectual nature of the Accord and the necessity of the Bank Holding Company Act, the basic system remained the same. While certain abuses might have been curtailed and the nominal independence of the Federal Reserve was presumably secure, nothing really changed for the average person. Perhaps helping to obscure the underlying problems with the economy and the financial system was the link established between the danger of foreign domination and socialism. The dangers of both were quite real and immediate. Many people, however, were apparently convinced that socialism and capitalism were somehow fundamentally different, and that "capitalism," "free market," "freedom," and "democracy" were somehow synonymous.

In 1958, however, Louis Kelso and Mortimer Adler published what may yet be recognized as one of the most genuinely revolutionary treatises of the 20th century, the misleadingly titled, The Capitalist Manifesto. The book's title as well as the subtitle were virtually guaranteed to appeal to newly dependent Americans of the 1950s given the widespread virtual obsession with communism and yet, at the same time, help shake them out of their complacency. As the subtitle expressed the purpose of the book, "A revolutionary plan for a capitalistic distribution of wealthy — to preserve our free society." [Emphasis in the original.]

By "capitalism," Kelso and Adler meant an economic system in which capital, not human labor, is the predominant factor of production, not the more accepted definition of an economic system characterized by ownership of the means of production concentrated in the hands of a relatively small private elite instead of in the State. The notion that the plan would preserve rather than restore the presumably free society of the United States was also somewhat problematical — but authors don't usually sell books or convince people of a course of action by insulting them. If Americans believed themselves to be free people instead of economic dependents of the State and central bank, then so be it . . . as long as they listened.

Somewhat surprisingly, many people did listen. The book became a best seller. As Kelso's ideas took hold and began to gain popularity (Adler described his contribution as tying Kelso's economic ideas in to the dignity of the human person exhibited in political democracy), prominent economists with a stake in the current system such as Paul Samuelson and Milton Friedman felt compelled to ridicule the proposals. Both Nobel Laureates, however, stopped there, and did not offer any substantive critiques of the Kelso ideas. They preferred to state dogmatically (Friedman's actual word choice) that they rejected what became known as "binary economics" without having to give reasons.

In this blog series we have discovered that Keynesians and Monetarists (as well as Austrians) base their economic theories on the tenets of the Currency School. It thus appears that the reason, e.g., Drs. Samuelson and Friedman refused to debate the issues was that they were not prepared to deal with or even understand a system based on the tenets of the Banking School, especially the real bills doctrine and Say's Law of Markets. They committed what amounts to the ultimate intellectual crime of judging another system not on the soundness of the principles of that other system, but on their own principles — in essence, blaming black for not being white, or vice versa. The popularity of this technique in nearly all fields of thought does not, however, lend it any degree of legitimacy. As G. K. Chesterton explains,

It is no good to tell an atheist that he is an atheist; or to charge a denier of immortality with the infamy of denying it; or to imagine that one can force an opponent to admit he is wrong, by proving that he is wrong on somebody else's principles, but not on his own. After the great example of St. Thomas, the principle stands, or ought always to have stood established; that we must either not argue with a man at all, or we must argue on his grounds and not ours. (The Dumb Ox, 95.)

This brings in how, exactly, the views of Friedman and Samuelson differ from those of Kelso with respect to the role of the central bank and, more broadly, that of the State itself. For both Keynesians and Monetarists the Federal Reserve System is, ultimately, a mere money machine for the federal government, generating funds through open market operations dealing in government securities. For an adherent of the Currency School, the central bank is not an institution designed and intended to provide the private sector with adequate liquidity by rediscounting commercial paper. The only issues that concern Keynesians, Monetarists, and Austrians are how best to operate that machine responsibly, and what principles are to guide the creation of new money so as — depending on your orientation — to increase, limit, or eliminate the power of the State.

Obviously the problem is that both Keynesians and Monetarists fail to address the real issue: the economic disenfranchisement of the ordinary person by the erection and maintenance of barriers to widespread ownership of the means of production. State control of the economy is a given, whether explicit as in Keynesianism, or implicit as in Monetarism and the Austrian schools. If any doubt remains on this point, ask a Keynesian, Monetarist, or Austrian how he or she defines 1) money and 2) private property, and how money and private property are linked, if at all.

For Kelso, private property — the chief support for human dignity — is the basis for any workable system, political or economic. Political and economic principles must be integrated consistently without distortion, with the goal of building political democracy on a solid foundation of economic democracy. Thus, respect for each individual's life, liberty, property and pursuit of happiness must not only be paid lip service, but be incorporated into the legal systems and institutional structures of society at all levels. Securing each person's natural rights and protecting them by ensuring democratic access to the means of acquiring and possessing private property in the means of production is, as Kelso and Adler claimed, a more effective counter to communism than government regulation or McCarthyism.

Presenting such ideas to Americans who had so recently been forced into a condition of dependency — wage slavery (not a Marxist, but an Aristotelian concept, as Adler explained) — was something of a problem. In The Capitalist Manifesto, Kelso and Adler make the moral, economic, and political case for widespread direct ownership of the means of production, thereby laying the groundwork for what the Center for Economic and Social Justice would distill as the four pillars of an economically just society:

1. Limited economic role for the State,

2. Free and open markets as the best means for determining just wages, just prices, and just profits,

3. Restoration of the rights of private property, especially in corporate equity, and (the "fatal omission" from both capitalism and socialism)

4. Widespread direct ownership of the means of production.

Kelso and Adler also dealt with another very serious problem. The economic disenfranchisement of the great mass of people noted by Grosscup early in the 20th century had advanced in tandem with a diminished understanding of private property and, of course, those institutions derived from private property, particularly money and credit, to say nothing of the control over one's own life that property confers. In March 1957, the year prior to the publication of The Capitalist Manifesto, Kelso published "Karl Marx: The Almost Capitalist" in the American Bar Association Journal. In part, the article targeted the wide misunderstanding of property and its importance in the political and economic order. In a few brief sentences Kelso detailed an understanding of property that all economists and lawyers should keep in mind when tempted to interfere with basic human rights to achieve some transitory or politically expedient good:

It may be helpful to take note of what the concept "property" means in law and economics. It is an aggregate of the rights, powers and privileges, recognized by the laws of the nation, which an individual may possess with respect to various objects. Property is not the object owned, but the sum total of the "rights" which an individual may "own" in such an object. These in general include the rights of (1) possessing, (2) excluding others, (3) disposing or transferring, (4) using, (5) enjoying the fruits, profits, product or increase, and (6) of destroying or injuring, if the owner so desires. In a civilized society, these rights are only as effective as the laws which provide for their enforcement. The English common law, adopted into the fabric of American law, recognizes that the rights of property are subject to the limitations that

(1) things owned may not be so used as to injure others or the property of others, and

(2) that they may not be used in ways contrary to the general welfare of the people as a whole. From this definition of private property, a purely functional and practical understanding of the nature of property becomes clear.

Property in everyday life, is the right of control.

The main problem facing Kelso was that, under the mercantilist assumptions of the Currency School — and keep in mind that the tenets of the Currency School are the cornerstone of all mainstream schools of economic thought, especially the dogmatic belief that capital formation can only be financed out of existing accumulations of savings — ownership of the means of production must be concentrated to finance new capital formation.

This "slavery" to existing accumulations of savings results necessarily in mainstream economics rejecting the real bills doctrine and Say's Law of Markets. This is true if for no other reason that both the real bills doctrine and Say's Law are built on the assumption that "money" is a derivative of the present value of existing or future marketable goods and services. This assumption (or, more accurately, an observation of reality) undermines the absolute dogmatism of the presumed necessity of existing accumulations of savings to finance new capital formation.

Eliminating our dependency on existing accumulations of savings as the source of financing new capital formation changes our understanding of the proper role of a central bank, especially the Federal Reserve System. In its original conception, the Federal Reserve, by its mandate to provide an elastic currency for qualified industrial, commercial, and agricultural investment, had the potential to provide every citizen with access (through the commercial banking system) to the means of acquiring and possessing private property in the means of production.

This power was gradually whittled away in response to demands of political expedience and the shift in mainstream economics away from the principles of the Banking School. The result is that the Federal Reserve has been transformed from the chief vehicle for managing a sound and stable currency for private sector development, into a means whereby the State is able to manipulate the currency for political ends and to implement fundamentally unsound economic policy in furtherance of those ends.

Emancipating humanity from the "slavery of savings" that had forced a condition of dependency on a people presumed to be the most free on earth was, ultimately, the point of Kelso's work. This inherent respect for the dignity of the human person is the reason why Adler found Kelso's ideas to be, in his opinion, one of the most important contributions to human thought in the 20th century.

Once the economic system has been freed from the slavery of savings — that is, the assumption that only existing accumulations of savings can be used to finance capital formation — the rest is relatively simple, although convincing policymakers of its rightness and utility would take another fifteen years. Even then, the "victory" was only partial. The system remains oriented in conformity with the principles of the Currency School, and academic economists and policymakers are still enslaved to past savings.

The mechanism Kelso invented to implement his theories was the "Employee Stock Ownership Plan," or "ESOP." Many people even today assume that Kelso first invented the ESOP, and then developed the theories that became known as binary economics to support his invention. This is incorrect. Kelso first developed the theories, then applied them more or less consistently.

The immediate question, of course, was how workers without savings and without existing ownership stakes could become part owners of the companies that employed them. As the bulk of production shifts to capital from labor, the market value of human labor (though, of course, not human beings) declines relative to capital. At that point, it becomes necessary to supplement and, in some cases replace labor income (wages/salaries) with ownership income (dividends/profits), just as Morrison observed in 1854. Without accumulated savings to use to purchase capital outright, or existing ownership of wealth to use as collateral, however, how can propertyless workers (and, eventually, everyone) become owners of capital?

The answer: through the application of the real bills doctrine and Say's Law of Markets. A company has a present value based on the anticipated future stream of profits to be generated by the production of marketable goods and services. Workers can purchase this present value on credit, and repay the acquisition loan out of future profits realized from the sale of marketable goods and services. The ESOP was designed to facilitate worker ownership on these terms.

Specifically, an ESOP is an expanded ownership mechanism "qualified" as a "defined contribution plan" under U.S. retirement law. That is, a participant in an ESOP is entitled to the value of his or her total vested benefit in the Plan, but nothing more. This is in contrast to a "defined benefit plan" in which a participant is entitled to a fixed ("defined") benefit whether or not the retirement trust has the funds. By its nature, an ESOP cannot go bankrupt, even if the sponsoring company goes under, where a standard defined benefit plan can go — and, in these days, frequently has gone — bankrupt, even driving the sponsoring company into bankruptcy due to underfunding of its pension liability.

The ESOP is a trust that can borrow on behalf of workers as a group to acquire ownership of the employer company, repayable with pre-tax profits or dividends. In current law, ESOPs can be either leveraged (designed to borrow to acquire company shares) or unleveraged (the shares are contributed by the employer). Typically an ESOP does not require workers to use their own savings or wages to acquire their shares, or to pledge their personal assets as collateral in a leveraged transaction.

In an ideal world, or at least a world in which the central bank had not been diverted into being the chief financing source for the State instead of the primary manager of the money supply for the private sector, a financing and ownership vehicle like the ESOP would have taken the world by storm immediately. As it was, it very nearly did, but it took a decade and a half to get the process started, and still remains today only a small start on the effort to make the economy run for the benefit of everyone, not just a select few.

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Own the Fed, Part XIII: Full Employment

With the end of the Second World War the triumph of Keynesian economics seemed absolute. The end of the Great Depression with the war appeared to have validated the New Deal. As a result, the transformation was complete of the American economy from the ownership-centered system epitomized by Abraham Lincoln's 1862 Homestead Act, to the near-universal wage and welfare system supported by massive government spending financed by debt-backed money created by the Federal Reserve System.

Nowhere was this new orientation more evident than with the passage of the Employment Act of 1946 (15 U.S.C. § 1021), introduced by Congressman John William Wright Patman of Texas. The Act was, in essence, another misdirected New Deal-style attempt to assign the State responsibility for every person's individual good and guarantee equality of results rather than equality of opportunity. Keynesian economics with its emphasis on full employment relies absolutely on the realignment of the Federal Reserve from an institution founded to provide the private sector with sufficient liquidity, to a vehicle for financing government deficits.

Ironically, Wright Patman was a vocal opponent of the Federal Reserve System. In a supreme political paradox, Wright Patman made a point of attacking the very institution he needed to achieve his goal. Had Wright Patman instead used his considerable influence to push for returning the Federal Reserve to its original purpose, there is every possibility that the goal of full employment would have been reached naturally, especially when adding in the later recommendations of Louis Kelso and Mortimer Adler for expanded ownership found in The Capitalist Manifesto (1958) and The New Capitalists (1961).

The statist orientation of the Employment Act is obvious. The chief purpose of the Employment Act was to vest the federal government with primary responsibility for economic stability. In the Keynesian paradigm, "economic stability" means full employment achieved through monetary policy (manipulation of interest rates and reserve requirements), and application of fiscal tools (taxation and spending) to maintain the economy in equilibrium.

This is not the place to examine the deficiencies of the Keynesian paradigm or the inadequacy of the monetary and fiscal tools used to attempt to reach and maintain equilibrium. We have already done that sufficiently in preceding postings. The question we want to address at this point is the assumption that "full employment" necessarily means employment of everyone in a wage system job, and the fact that full employment so defined cannot be attempted without massive State intervention in the economy financed by central bank monetization of government deficits.

Keynes realized that full employment as he defined it and under his assumption of the necessity of existing accumulations of savings to finance capital formation could not be achieved other than by a centrally planned and controlled economy. To do him justice, socialism was likely not a goal Keynes sought as an end in itself. Trapped by his assumptions, however, especially his dogmatic faith in existing accumulations of savings, Keynes could not see any other way to make the system work. Control of the economy was to be achieved through manipulation of money and credit. This could only be done by vesting effective ownership of the total wealth of the nation in the State, to be exercised by State control over money and credit through the central bank. (General Theory, op. cit., V.24.iii; cf. Thomas Hobbes, "Propriety of a Subject Excludes Not the Dominion of the Soveraign, But Onely of Another Subject," Leviathan, XXIV.)

The Employment Act of 1946 had its origin in the Full Employment Bill of 1945, introduced by Senator James Murray of Montana. The bill had three primary elements: 1) Every American "able to work and seeking work" is entitled to regular, full-time employment as a basic right. 2) The establishment of a central planning mechanism, the "National Production and Employment Budget," to identify potential areas in which spending and investment might be expected to fall short. 3) Federal government encouragement of private sector initiatives backed up with government money when necessary. All three elements would have put control over the private sector in the hands of the federal government.

The bill was defeated, but the problem remained. With the end of the war, unemployment was expected to soar once again as returning servicemen and women reentered the workforce. The problem was how to stimulate the economy, create jobs, and prevent another economic downturn such as had occurred after the Civil War and the First World War. The trick was to keep the economy going at wartime levels during peacetime, and somehow ensure that the presumably limited supply of investment capital (the accumulated pool of existing savings) was not diverted into speculative ventures, but directed toward genuinely productive investment.

Keynesian economics, credited with bringing the United States out of the Great Depression, was the basis for formulating an approach intended to safeguard against future economic downturns. Of the various factors contributing to swings in the business cycle, Keynes identified investment as having the most significant effect on aggregate demand.

Keynes decided that the only way to fine tune the economy and keep everything running smoothly was to increase aggregate demand by redistributing mass purchasing power by inflating the currency. This would spur additional investment, as well as provide the financing for new investment through "forced" or "involuntary" savings that shifts purchasing power from consumers to producers by increasing prices. Moulton conclusively proved this theory false in The Formation of Capital in 1935, but the New Deal and the Second World War had confirmed Keynesianism and its reliance on redistribution of existing wealth over the operation of the real bills doctrine and Say's Law of Markets as the new economic orthodoxy.

The idea is that if you need more investment to create jobs, you inflate the currency. If inflation gets too high, you either don't inflate quite so fast, or deflate the currency, with the unfortunate side effect that unemployment increases. When that happens, the government should redistribute existing wealth to make up for the jobs that are lost, either distributing welfare directly, or subsidizing job creation.

This program would be impossible without the full cooperation of the central bank operated in conformity with the tenets of the Currency School instead of principles of commercial and central banking: the Federal Reserve System. In no other way would the federal government be able to redistribute through inflation without formally abolishing private property, or by instituting confiscatory taxation based on the assumption of effective State ownership (shades of the "single tax" proposed by Henry George in Progress and Poverty, New York: The Robert Schalkenbach Foundation, 1992, 406).

Consequently, Wright Patman introduced the Full Employment Bill of 1946. The original version of the bill established a wage system job as a basic right of every American, and mandated the federal government to do everything in its considerably expanded authority to reach full employment. An important feature of the bill was to require the president of the United States to submit an annual report to Congress as a supplement to the national budget. This report, the "Economic Report of the President," would estimate the projected employment rate for the coming fiscal year. If the projected employment rate was less than the full employment rate, the bill authorized spending mandates to attain full employment.

Opposition to the bill fell into three basic categories. 1) A significant number of congressmen believed that the free enterprise system naturally included swings in the business cycle (which is true under the assumption that only existing accumulations of savings can be used to finance capital formation). Government spending to compensate for swings in the business cycle could only be justified in the most extreme cases. A few congressmen believed that a free enterprise economy would reach full employment without government intervention (yes — given the removal of barriers to full participation in the economic process, especially barriers to ownership). 2) Other congressmen believed that neither the government nor anyone else could accurately forecast unemployment. 3) At least a few congressmen were wary of the idea that the federal government could guarantee full employment. After a good deal of politicking that removed the absolute guarantee of full employment (as well as the word "full" from the title of the bill) and the mandate for spending to reach that goal, President Truman signed the Employment Act of 1946 on February 20, 1946.

Even though the Act as passed was something of a shadow of what Wright Patman intended (fortunately so, from the standpoint of fiscal responsibility and attempting to limit the State to its proper role), the Employment Act was an extremely important piece of legislation, one of the most significant legislative acts of the 20th century. The significance was twofold. One, the Act established that the federal government has power over the entire economy. Two, the government was encouraged to "promote maximum employment, production, and purchasing power." This latter laid the groundwork for a union of the public sector and the private sector that culminated in the "Great Society" programs under President Johnson in the 1960s. The Act also created the Council of Economic Advisors to assist the president in formulating economic policy, as well as the Joint Economic Committee to review economic policy.

Although the Employment Act of 1946 ended up being a set of suggestions rather than a list of mandates and guarantees, the effect was to increase the power of the federal government enormously, especially over the Federal Reserve System. The Act officially recognized the federal government as being directly in charge of national prosperity, with the tacit understanding that the Federal Reserve would be the means of financing the effort. With the passage of the Act the United States officially abandoned its commitment to promoting widespread direct ownership of the means of production.

Still, while effectively a surrender to the dogmas of Keynesian economics, the Full Employment Act was, in a manner of speaking, only a matter of form. Lincoln's original Homestead Act of 1862 addressed only a single type of productive asset, land, by its nature limited. It left untouched the growing problem of the increasing concentration of ownership of industrial and commercial capital. By the early 20th century this had become a serious problem.

In a process chronicled by one of President Theodore Roosevelt's "Trust Busters," Peter Stenger Grosscup, Judge of the United States Circuit Court of Appeals from 1899 to 1911, in a series of articles in popular magazines, (See, e.g., "How to Save the Corporation," McClure's Magazine, February 1905; "Who Shall Own America?" American Illustrated Magazine, December 1905; "The Rebirth of the Corporation," American Illustrated Magazine, June 1906; "The Corporation and the People," The Outlook, January 12, 1907.) people were losing ownership of small farms and shops at an increasing rate. They were becoming completely dependent on wage system jobs for either the greater part or the totality of their subsistence.

The Great Depression and the vastly increased demand for labor in the Second World War effectively finished off small ownership in the United States. The war spurred technological advances not even thought of in previous generations. The country achieved the only period of genuine full employment in the 20th century. The vast majority of the production was not in the form of marketable goods and services, however, but war material. Further, ownership of the means of production was concentrated in very few hands.

As we have seen, Keynesian economics assumes as a given that ownership of the means of production must be concentrated, and that the vast majority of people should not own:

I see, therefore, the rentier [small owner who lives off the income from investments] aspect of capitalism as a transitional phase which will disappear when it has done its work. And with the disappearance of its rentier aspect much else in it besides will suffer a sea-change. It will be, moreover, a great advantage of the order of events which I am advocating, that the euthanasia of the rentier, of the functionless investor, will be nothing sudden, merely a gradual but prolonged continuance of what we have seen recently in Great Britain, and will need no revolution. (The General Theory of Employment, Interest, and Money (1936), VI.24.ii.)

Instead, people should rely solely on wages and welfare for their consumption incomes. According to Keynes, the maldistribution of ownership of the means of production that forces people into the wage system is not only a given, but a desirable state of affairs. (John Maynard Keynes, The General Theory (1936), VI.24.i.) As he stated in The Economic Consequences of the Peace, the 1919 book that established his reputation,

The immense accumulations of fixed capital which, to the great benefit of mankind, were built up during the half century before the war, could never have come about in a Society where wealth was divided equitably. (John Maynard Keynes, The Economic Consequences of the Peace (1919), 2.III.)

Consequently, the emphasis switched from making the economy productive in as efficient and cost effective manner as possible, to employing as many people as possible, whether or not their labor was actually necessary as an input to production. The Department of Labor began to assume a far greater importance than the Department of Commerce, and government policy became almost completely integrated into the wage system approach to economic growth and development.

Aside from the Dow Jones Industrial Average — a misleading and grossly inaccurate measure of economic performance — the unemployment figures became one of the most important leading economic indicators studied by academics and government policymakers. Given the reliance by the federal government, academia, and the economic establishment on unemployment data, the unemployment rate is one of the most critical of our leading economic indicators. The U. S. Department of Labor Bureau of Labor Statistics defines unemployment as a leading economic indicator in these terms: "An estimate of the number of payroll jobs at all nonfarm business establishments and government agencies. Information is also provided on the average number of hours worked per week and average hourly and weekly earnings."

According to the Bureau of Labor Statistics, the reason unemployment is such an important leading economic indicator is that the growth of employment and hours worked presumably provides important information about the current and likely future pace of overall economic growth. Trends in average hourly earnings provide information about supply and demand conditions in labor markets, which may provide signals about the overall level of resource utilization in the economy.

Obviously, using unemployment as a leading economic indicator assumes the validity of Keynes's assumption that most people can only gain income through wages and welfare, not ownership, and that a stable economy can be established by concentrating on full employment, rather than full production as was achieved in the Second World War, and on full ownership, as was the goal of the Homestead Act of 1862.

Thus we have the misguided focus on "job creation" without first asking whether the jobs are necessary. Artificial job creation is simply a complicated form of redistribution. If employers are given direct cash payments from the State, the money can only come from taxing other people directly and thereby reducing their income, or by inflating the currency by printing money, thereby reducing everyone's real income through the "hidden tax" of inflation by making each unit of currency purchase that much less. If an employer is given a tax credit, that is, a dollar-for-dollar reduction in the tax liability, that simply means other taxpayers must make up the shortfall, or the State must print more money, with the same results.

The bottom line is that, unless jobs are created naturally because the labor is needed as an input to increased production, job creation only divides up a shrinking pie into smaller and smaller pieces. Keynes's approach is ultimately self-defeating. Unless production increases, you won't need additional labor input, and real aggregate income will not increase: in accordance with Say's Law of Markets, production equals income. Instead, all you will accomplish is to redistribute what already exists.

From a theoretical standpoint, perhaps one of the biggest problems with the obsession with the unemployment rate is that it fails to take anything other than labor into account as a factor of production. Traditionally, economists have listed the factors of production as land, labor, and capital. Nowadays, many economists add entrepreneurship and "human capital." When measures of "productivity" are given, however, the role of the factors in the economy is ignored, and the statistic is given exclusively in terms of labor productivity, leaving out land, capital (human or otherwise), and entrepreneurship.

The effect of measuring productivity exclusively in terms of output per labor hour distorts the contribution by the other factors of production, and places what may be too much importance on the unemployment rate as a measure of economic growth. The approach of Louis Kelso is a more realistic — and therefore more useful — way of looking at the matter.

Kelso divided the factors of production into two, the human (labor), and the non-human (capital — including land and natural resources). Instead of measuring productivity in terms of output per labor hour, Kelso used the concept of "productiveness," that is, an expression of the pro rata contribution of each economic factor to production, as measured by the market-determined value each factor contributes to the overall production process. In contrast, "productivity" measures economic output strictly in terms of one factor (labor) alone, while treating the contribution of technology and other forms of productive capital as irrelevant for income distribution. (See Louis Kelso, Two-Factor Theory: The Economics of Reality. New York: Random House, 1967.)

In an age in which labor as a factor of production is decreasing rapidly relative to the contribution by capital, using the traditional understanding of productivity can lead to patently ridiculous conclusions. As Dr. Robert H. A. Ashford describes one such scenario,

Consider the effect on the productivity calculation when the numerator is company elevator output, or some national or other output aggregate, but the denominator is the remaining operators. When the remaining operators are the denominator, productivity is increased because the same or more service is being delivered by fewer operators and so a lower labor cost. The alleged increased productivity is, of course, ludicrous. In reality, the remaining operators are working as before delivering the identical service in the same time. They are not working any more productively. To the contrary, only capital (the automated elevators) is doing more work and, as a percentage of the input, labor is doing less. Productivity is further increased as the number of operators decreases. Productivity increases even further [with one operator]. Productivity leaps skywards with just a single part-time operator. It then goes on an astronomical rise when there is a part-time operator doing only a few minutes' work each day. With no operators, productivity has risen to infinity! (Binary Economics: The New Paradigm. Lanham, Maryland: University Press of America, 1999, 150-151.)

Emphasis on labor as the sole factor of production has the expected effect of exaggerating the importance of a wage system job, and of denigrating or even ignoring completely the importance of widespread ownership of the means of production as a necessary complement to wage income to distribute income.

This misdirection, even misunderstanding of production and distribution leads to an overemphasis on full employment of labor in wage system jobs as the goal of an economy, rather than full employment of all resources and participation in the economic process as worker, owner, and consumer.

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Own the Fed, Part XII: The Crisis of 1937 and the Second World War

As we have seen, the Great Depression confirmed that the general policy of the Federal Reserve System had changed from the original intent of the framers of the Federal Reserve Act of 1913. The policy of the central bank of the United States was now and remains based on the tenets of the Currency School. Despite assertions to the contrary that continue to this day (see, e.g., Tim Todd, The Balance of Power: The Political Fight for an Independent Central Bank, 1790-Present. Kansas City, MO: Public Affairs Department of the Federal Reserve Bank of Kansas City, 2009), the increasing degree of political control accompanying the New Deal removed the last effective remnants of the Federal Reserve's claim to independence.

The central bank's loss of what remained of its independence signaled the final shift in monetary policy away from the principles of the Banking School, principally Say's Law of Markets and the real bills doctrine, and made the Federal Reserve System to all intents and purposes an unaccountable branch of the federal government. Its mission was changed into serving political ends of the State, rather than economic and financial ends of the private sector. As Harold G. Moulton observed,

Under the new organization, as we have seen, the powers of the Board of Governors have been greatly expanded, thereby circumscribing the independence of action of the member banks; and at the same time the Board of Governors has been place more definitely under political control. This is accomplished through that provision of the law which makes the governor of the Board removable at the will of the President.

This shift is a reflection of the philosophy that not only is it a proper function of the Government to assume control over the entire credit system, but that only the Government can be depended upon to exercise such control in the interest of the public welfare as a whole. This conception appears to be the result of two factors — the failure of the former system of control to prevent financial crises, and the greatly increased importance of government fiscal and financial operations in the larger scheme of things. Whether the new alignment will be able to avoid the weaknesses disclosed in former periods of political control, time will demonstrate. As will be noted in the following chapter a similar trend is strongly in evidence in other countries. (Financial Organization and the Economic System, op. cit., 417.)

Whether the change in the understanding of money and credit under the Currency School resulted, as John Maynard Keynes asserted, from the growth of State authoritarianism (A Treatise on Money, Volume I: The Pure Theory of Money. New York: Harcourt, Brace and Company, 1930, 4), or whether State authoritarianism gained its foothold as a result of the change in the understanding of money and credit (while an issue of immense importance) is not our interest in this survey. Our concern is not why what happened, happened, but what happened, and, later, how best to correct the situation. Identification, pursuit, and punishment of ignorant individuals and groups guilty only of a lack of understanding and consequent egregious misuse of the system is not our concern, and is a waste of time in any event.

What happened has become increasingly clear as we examine the history of the Federal Reserve. By the time the Crisis of 1920 occurred, the Federal Reserve System had already undergone a major shift in direction. In order to finance the entry of the United States into the First World War without recourse to taxation, the federal government found a way to finance government operations through borrowing and money creation. This was in spite of the strenuous attempts that the framers of the Federal Reserve Act of 1913 made to prevent this very thing from happening, and the decades of misery caused by Salmon Chase's decision to finance the Union war effort in the Civil War the same way.

Almost immediately after the First World War, in 1920, money creation for speculative purposes threatened the health of the economy and the financial system. At that time, the simple announcement that the Federal Reserve was planning on raising the discount rate and reserve ratios to dampen down the "overheated" economy was enough to restore confidence and redirect money creation toward sound investment and away from speculation. Even though the Federal Reserve didn't actually do anything, the announced plan to manipulate the discount rate and reserve ratios gave the appearance that the Federal Reserve had effective tools at its command to control the economy. Confidence was restored and the economy returned to an apparently healthy condition.

The immediate cause of the Crash of 1929 was the creation of massive amounts of money for speculative purposes, principally the purchase and bidding up the price of unsound share issuances on the secondary market. The Federal Reserve attempted to reduce the loans made by commercial banks for speculative purposes (over which it had no real control) by taking punitive action against loans made by commercial banks for productive purposes — over which it did have control. Efforts by the Federal Reserve were completely ineffectual in reducing the loans made for speculative purposes and commercial banks avidly took up the slack. The only result of the Federal Reserve's action was to ensure that productive businesses assumed a burden of debt that they would be unable to service in the ordinary course of events.

Still under the illusion that it could control the money supply indirectly by controlling interest rates and manipulating reserve ratios instead of directly through applications of Say's Law of Markets and the real bills doctrine, the Federal Reserve attempted to stimulate the revival of business following the Crash of 1929 by — as we might expect — controlling interest rates and manipulating reserve ratios. This had, to all appearances, been successful in averting a serious business downturn in the Crisis of 1920, although closer examination of the situation would have revealed that the policy had not actually been implemented. Consequently, the presumably effective yet untested techniques were applied following the Crash, but with disastrous results. Banks stopped lending, and the economy went into a tailspin.

Federal Reserve authorities clearly believed that money and credit would behave in the same manner as a commodity or any other marketable good or service. The Federal Reserve therefore continued to act contrary to the true nature of money and credit, and lowered the discount rate in order to stimulate the economy. Since the problem was not the "price" of money, but the fact that businesses lacked sufficient or adequate collateral to qualify for loans, banks could not justify making loans to business. Consequently, loans were not made.

To explain the failure of banks to make loans, Keynesian economics asserted that the economy was in a "liquidity trap" due to the infinite elasticity of money. The problem with the Keynesian explanation is that money is not a marketable good or service. Money is a derivative of marketable goods and services, dependent on the present value of existing and future marketable goods and services for its legitimacy. Accordingly, the laws of supply and demand do not apply directly to money and credit.

Even given the ineffective remedies implemented by the Federal Reserve to stimulate business combined with the apparent anti-business orientation of much of the New Deal, by the mid-1930s the country was beginning to recover, at least slowly. The Dow Jones Industrial Average would nearly quadruple by August of 1937, although unemployment remained at high, almost intolerable levels, given the potential of America to produce in quantities sufficient both to meet demand and to provide jobs for anybody that wanted one. (See Harold Moulton, America's Capacity to Produce. Washington, DC: The Brookings Institutions, 1934; Harold Moulton, America's Capacity to Consume. Washington, DC: The Brookings Institution, 1934; Harold Moulton, Capital Expansion, Employment, and Economic Stability. Washington, DC: The Brookings Institution, 1940.)

Policymakers and Federal Reserve authorities were, however, still unable either to distinguish between good and bad uses of credit, or develop and implement an effective means of curbing speculative money creation without harming the genuinely productive sector. As a result, Moulton observed that, "Business and financial trends since the reorganization of the Reserve system have afforded opportunity to test the new process of control through a period of expansion culminating in a new depression." (Financial Organization and the Economic System, op. cit., 411.) Language of this sort was a departure from Moulton's usual extremely diplomatic phrasing. It puts the blame for the "new depression" squarely on the shoulders of the inept new policies implemented by the Federal Reserve authorities at the behest of New Deal politicians — which is where it clearly belonged.

Specifically, concerned that the economy was growing faster than was warranted — or (more accurately) that it might grow faster than it should, Federal Reserve authorities began applying brakes to the economy by increasing reserve ratios. The Treasury cooperated by implementing a policy designed to inhibit or prevent additional acquisition of gold to use as reserves, a process that became known as "gold sterilization." (Financial Organization and the Economic System, op. cit., 412.) As Moulton commented, "The Treasury and Federal Reserve measures taken together largely eliminated the basis of potential credit expansion." [Emphasis in original.] (Ibid., 413.)

In other words, because the people in authority who fancied themselves in charge of the economy decided that economic growth might become (in today's terminology) "overheated," they ensured that many of the gains that had recently been achieved against almost insurmountable odds were wiped out. Amity Shlaes blames the undistributed profits tax for the sudden downturn, although it is evident that, like the speculative frenzy that preceded the Crash of 1929, the undistributed profits tax was only the trigger that exposed and took advantage of serious weaknesses in the system. As she comments in her "New History of the Great Depression," exhibiting her own adherence to chief tenet of the Currency School (that existing accumulations of savings are essential to new capital formation),

The same day that it reported Mellon's death, the New York Times carried a story on the consequences of the undistributed profits tax. Companies that had formerly sought to retain employees through downturns now no longer had the reserves to do so. They had likewise ceased to invest in new equipment, normally a traditional move in slow periods. The headline on the story was: "Levy on Profits Halts Expansion." What would happen to the meager recovery? Stocks had begun dropping in mid-August. Now they accelerated their decline. . . . By the next Monday the worriers had their answer. Bond prices plummeted farther than they had on any single day in three years. Businesses and investors did not want to buy money anymore because they did not want to use it. . . . As for stock shares, they were down between $2 and $15, the greatest drop in six years. In recent times, before this panic, the market had been "thin" — relatively few shares had traded, at least when compared with pre-Depression days. This panic, though, was so broad and trading so furious that the ticker closed seventeen minutes late. The traders were finally awakening, just as everyone had hoped they would. But they were awakening only to run. (The Forgotten Man: A New History of the Great Depression, op. cit., 334-335.)

The weaknesses in this analysis are immediately evident to anyone familiar with the principles of binary economics, especially as detailed in The New Capitalists: A Proposal to Free Economic Growth from the Slavery of Savings (op. cit.), but that is not the point. What is clear is that government policy and the move toward economic central planning, to say nothing of the not-unexpected results of basing a recovery of confidence in the economy not on the strength of the system itself, but in the admittedly strong personality of FDR, had a result that should have been anticipated.

Ignoring the natural law basis for the principles of the Banking School, notably Say's Law of Markets and the real bills doctrine, could only lead to disaster — and it did. As Horace reminded us, "You can chase Nature out with a pitchfork, but she always comes back." (Naturam expelles furca, tamen usque recurret. Epistulae I.x.24) You cannot separate money — a derivative of production — from the production from which it naturally derives without undermining the stability of the system that relies (as does every economy) on production, not on redistributing what exists, whether marketable goods and services, or claims on marketable goods and services in the form of money.

The only thing worse is separating currency — a derivative of money — from production, and allowing the State to manipulate the "money" supply (narrowly defined) at will for dubious political ends. Perhaps not unexpectedly, to offset the correction, the Federal Reserve decided to reverse its policy, and institute a policy of "easy" credit. Of course, the problem remained: an inability or refusal to differentiate between "bad" uses of credit (speculation, consumption, and government spending), and "good" uses of credit: financing financially feasible new capital formation. The result was only to be expected. As Moulton explained,

In the spring of 1938 it was deemed wise to ease the reserve position again in the hope of promoting a new credit expansion. Hence, on April 14, 1938, reserve requirements were reduced to 12, 17 1/2, and 22 3/4, per cent respectively for the three classes of member banks.

That these policies did not prove effective in controlling the general business situation is all too evident. Since the spring of 1937 we have had a stock market collapse and an acute business depression. As may be observed by referring again to the movement of stock prices in the chart on page 226, and to the general trend of business as shown in the chart on page 342. The current fluctuations have been quite as sharp as those of former times. The inability of the Board of Governors of the Federal Reserve system to control the business situation is simply evidence that many of the forces, which account for business fluctuations, lie beyond the control of monetary policy. (Financial Organization and the Economic System, op. cit., 416.)

It would be more accurate to say that "the inability of the Board of Governors of the Federal Reserve system to control the business situation" lies "beyond the control of monetary policy" — as currently understood. Again, this is an important point that is frequently overlooked. Federal Reserve policy, as well as virtually all academic economics and government policy, is predicated on the assumption that the disproved principles of the Currency School are, in fact, as absolute and unquestioned as any religious dogma. Aside from the obvious problems that result from attempting to base a matter of science on faith rather than reason, the fact remains that, try as you will, you will never get an acceptable result from your efforts if you insist on going contrary to reality.

Keynes, in his famed chiding "open letter" to Roosevelt in the New York Times of December 31, 1933 had attempted to convince the president that all would be well if only FDR would engage in greater redistribution through inflation, which Keynes claimed is not real inflation until full employment is reached: "When full employment is reached, any attempt to increase investment still further will set up a tendency in money-prices to rise without limit, irrespective of the marginal propensity to consume; i.e. we shall have reached a state of true inflation. Up to this point, however, rising prices will be associated with an increasing aggregate real income." (The General Theory of Employment, Interest, and Money, 1936, III.ii; see also V.21.v.) Since many economists define inflation as "rising prices," while others define it as any increase in the money supply, with or without an increase in the price level, we conclude that these different definitions are useful only insofar as they demonstrate a significant problem with basing economic analysis or (worse) government monetary and fiscal policy on the tenets of the Currency School.

Keynes's definition of "true inflation" is extremely valuable in one respect. We can blame Keynes quite properly for validating the New Deal and justifying increasing State intrusion into the economy, but he was not personally responsible for implementing his theories, whether in whole or in part. The blame for that must rest squarely on the shoulders of the politicians who first began using the central bank and distorting its mission to increase the power of the State. When the decision was made to finance yet another war by borrowing, Keynes objected strenuously.

Consistent with his theory that "true inflation" was only possible once full employment had been reached, Keynes was adamant that the United States should have financed its entry into the Second World War solely by increasing taxes (How to Pay for the War, 1940). According to Keynes, this would have prevented "true inflation," the buildup of unnecessary debt (already greatly enlarged as a result of the New Deal), and the imposition of rationing or wage and price controls. "Excess" income would have been taxed away, preventing an increase in the price level — rationing to prevent inflation is unnecessary if people don't have the money to spend and bid up prices.

As many writers have observed, increased spending by the government on New Deal programs did not get the United States out of the "mini-depression" of the mid-1930s. Instead, it was the increased demand for war production that created conditions of full employment.

Whatever actually brought about the full employment of the Second World War, the decision to finance America's entry into the conflict through borrowing rather than taxation was purely political. In this, the Congress simply followed the precedent established by Salmon P. Chase, Lincoln's Secretary of the Treasury, who sought to use his position to lever himself into the presidency (even to the extent of putting his own face on the $1 note to familiarize people with his appearance). The First World War provided a more efficient mechanism for funding government debt, one that (as we have seen) has become established as the normal mode of operation of most of the world's central banks and the means by which the State attempts to assert control over the economy, with increasingly disastrous results, as recent events have shown.

While Eisenhower warned of the dangers of "the military-industrial complex," Ike should rather have directed the attention of the people to the real and present danger inherent in the financial-political complex, the subversion of the financial system to serve the ends of the State rather than the needs of the private sector, as Henry C. Adams pointed out in his 1898 Public Debts: An Essay in the Science of Finance. As Moulton summed up his discussion in 1938 of the evolution of the Federal Reserve System up to that time,

In concluding this discussion of the Federal Reserve system attention should be called to a point of view embodied in the new legislation, which marks a profound departure from the conception that had prevailed during the long period from the Civil War to 1933. As a result of the experience of the early nineteenth century in connection with the First and Second national banks and in the light of banking history in other countries, the opinion had crystallized that an efficient monetary and banking system, responsive to the requirements of business, necessitated detachment from political control. This conviction was responsible for the Independent Treasury system; for the segregation of the monetary from the fiscal functions of the Government in the Currency Act of 1900; for vesting in the National Banking system the power to issue notes; and for the democratic organization of the Federal Reserve system and the independent political position accorded the members of the governing board. While the Secretary of the Treasury was ex officio a member of the Board, the view prevailed that the Treasury should not be permitted to dominate Reserve policies in the interests of government fiscal requirements. (Financial Organization of the Economic System, op. cit., 416-417.)

We can argue whether the Great Depression or the Second World War were avoidable. Doubtless there is a great deal that could have been done to prevent either from happening or to ameliorate the scope of the disasters. What this survey has shown, however, is that, regardless whether the lack of a Just Third Way understanding of and approach to economic problems could have prevented them from happening (certainly true in the case of the Great Depression, and possibly true with respect to the Second World War), how recovery was financed in the first case, and victory in the second case had serious repercussions that have continued to haunt us down to the present day.

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News from the Network, Vol. 3, No. 12

Federal Reserve Chairman Benjamin Bernanke has announced that the Federal Reserve will keep rates low in an effort to stimulate economic growth . . . so that he can start raising the rates. "Deciding when to tighten credit is the biggest challenge facing Bernanke, whose second term started in February. Moving too soon could short-circuit the recovery. Waiting too long could unleash inflation and sow the seeds for new speculative bubbles in stocks or commodities or other assets." There are so many things wrong with Mr. Bernanke's approach that it's difficult to know where to begin — but we can try.

One, low interest rates will presumably encourage banks to make more loans before the threatened rate increase harms their ability to extend credit. This reasoning fails to address the reason why banks aren't lending: qualified borrowers are not presenting themselves. Bottom line: to increase lending, banks would need to lower standards at a time when they are being told to tighten up standards. Making bad loans to poor prospects, however, is what caused the present problem in the first place, or at least provided the trigger. Corrective action: provide a mechanism — such as a private sector capital credit insurance and reinsurance corporation (or, better, a number of them to ensure competition) — by means of which otherwise qualified borrowers who lack adequate collateral can obtain loans on reasonable terms. Do not lower standards, raise them — but also provide the means by which people can meet those raised standards.

Two, low interest rates will presumably encourage job creation. No — lower rates on loans for which borrowers (meaning borrowers for productive purposes) qualify by having adequate capital in the form of capital credit insurance and reinsurance mean more capital investment. This increases the demand for labor and creates jobs naturally, not as an end in itself, which is wasteful and pointless. Better: permitting businesses to finance capital expansion on credit and cutting workers in on a share of the ownership so that they receive dividends to supplement their wage incomes increases both aggregate consumption power in the economy and individual purchasing power. Using future savings instead of existing accumulations of savings — as the real bills doctrine and Say's Law of Markets allows — frees the economy from the unnatural reliance on the accumulations of the wealthy and nonsensical decisions by politicians, speculators, and academic economists.

Three, fixing interest rates is pure socialism, whether you view money and credit as a commodity that responds to the laws of supply and demand, or whether you take the correct view in binary economics that "interest" is a lender's share of profits based on the natural right of private property. Whether you are fixing the price of a commodity or setting the rate of return due an owner, you are violating free market principles, the rights of private property, and plain common sense.

Four . . . we really could go on at great length, but let's cut to the chase. Mr. Bernanke's inability to formulate any coherent policy in the face of the financial meltdown — both the one that caused the present malaise, and the one that is coming — ("'The key point . . . is that the Fed is no closer to implementing its exit strategy,' said Paul Dales, an economist at Capital Economics.") is based on his lack of understanding of money, credit, and banking. Mr. Bernanke clearly is a devoted follower of Keynes, believing absolutely in the disproved Keynesian (and Monetarist and Austrian) dogma that the only way to finance new capital formation is through the use of existing accumulations of savings, with "savings" always defined as cutting consumption — always: the "paradox of thrift."

If savings equals investment, of course — another Keynesian dogma, although a correct one, for a change — the obvious conclusion within the false constraints imposed by accepting the tenets of the mercantilist Currency School is that no new capital formation can ever take place. This is because you must first liquidate an existing investment before financing new investment. Consequently the amount of investment in the system as a whole cannot increase. Presumably the "multiplier effect" takes care of this . . . except that, because Keynes rejected the real bills doctrine, the numbers in the Keynesian explanation of the multiplier effect don't add up — he evidently didn't realize that checks drawn on one bank and deposited in another bank do not stay in the second bank, but are presented to the first bank on which they are drawn for payment, leaving the amount of money in the system the same.

The bottom line is that Mr. Bernanke firmly believes that money is first created, thereby inflating the currency. This inflation causes "forced" or "involuntary" saving by reducing the purchasing power of the ordinary consumer: "saving." These savings are transferred — redistributed — to producers by means of the higher price level induced by the creation of money, and invested in new capital formation.

Uh huh.

As a good Keynesian, Mr. Bernanke rejects the real bills doctrine and Say's Law of Markets. The real bills doctrine is that money can be created without inflation IF the money creation is tied directly to the present value of existing or future marketable goods and services through the institution of private property.

A borrower can draw a "real bill" on this present value, and take the bill to a commercial bank. The bank issues a promissory note — "creates money" — and hands the note over to the borrower, taking a lien on the present value of the existing or future marketable goods and services in exchange. The borrower takes the promissory note (which the bank usually replaces with banknotes or, more often, demand deposits), invests in a capital project, and begins making profits. Out of the profits the borrower repays the loan — redeems the promissory note — and "buys back" the lien on the present value of his or her existing or future marketable goods and services.

As Jean-Baptiste Say pointed out in response to complaints about his theories by the Reverend Thomas Malthus, we do not, therefore, purchase the productions of others with "money," but with what we ourselves produce. If goods remain unsold, it is because other goods are not produced. Money is merely the mechanism by means of which we facilitate the exchange of what we produce for what others produce.

As Harold Moulton pointed out in his recommendations for recovery from the Great Depression, the key is production, not redistribution. (Income and Economic Progress. Washington, DC: The Brookings Institution, 1935.) Kelso and Adler add that everyone must share in the production through ownership as well as labor, thereby ensuring the broadest and fastest increase in mass purchasing power, stimulating sound recovery, not relying on inflation and artificial government intervention. In pursuit of these goals, we have made some progress over the past week:

• Last week a couple from Kenya with some interesting government connections visited CESJ co-founder Rev. Robert Brantley in Maryland. Bob quickly made contact with Norman Kurland, who traveled immediately for an extended meeting, staying overnight and participating in a series of important discussions. The Kenyans agreed — counter to a basic assumption of Keynesian economics that production is not a problem (but over-production is) — that production, as Dr. Harold Moulton reminded us in the 1930s, is key to restoring health to an economy. What Moulton left out, however, Kelso and Adler added: that everyone must have an equal opportunity to participate in production, both as a supplier of labor and as an owner of capital. The Kenyans were quite enthusiastic, and promised to study the material on the CESJ website.

• This week members of the CESJ core group met with a group from Johns Hopkins University. They had come across CESJ when searching for community development proposals in which young people could participate in a meaningful way. They found the Citizens Land Cooperative concept intriguing, and met with CESJ to discuss possible collaboration. Of course, while CESJ provides the theory, practical applications would be provided by Equity Expansion International, Inc., a for-profit enterprise in the Just Third Way network.

• One of the basic reforms we believe are necessary in order to implement Capital Homesteading effectively is to extend the term of paper that qualifies for rediscounting at the Federal Reserve. Traditionally, the term of loan paper rediscounted at a commercial or central bank has been ninety days — from the 17th century the maximum length of time anyone was willing to wait for the drawer of a bill to redeem or make good on the promise conveyed by the instrument. Because Capital Homesteading is not looking at financing short term working capital needs, but all capital needs of the economy, the term of qualified paper will have to be extended. We have been viewing this as a potential problem . . . until we discovered that on June 19, 1934, Congress passed a law as an emergency measure during the Great Depression permitting the term of qualified paper to be extended for up to five years. Further, contrary to accepted practice of central banking, businesses that could not find accommodation with a regular commercial bank could, under certain restrictive circumstances, go directly to the Federal Reserve banks for financing.

• As of this morning, we have had visitors from 45 different countries and 46 states and provinces in the United States and Canada to this blog over the past two months. Most visitors are from the United States, the UK, Canada, Brazil, and India. People in Venezuela, France, Rwanda, Ghana and Belgium spent the most average time on the blog. The most popular postings are "Thomas Hobbes on Private Property." "The Crash of 1929" in the "Own the Fed" series, Guy Stevenson's "Expanded Capital Ownership Now" and "Every Citizen an Owner" (tie), and "Henry Ford and John Maynard Keynes," also in the "Own the Fed" series. Evidently a more or less straightforward presentation of how the Federal Reserve transformed from a necessary provider of liquidity to the private sector, to an indispensable funding source for politically motivated government spending is striking a chord — and all without blaming anything on a hidden conspiracy, an effort that goes against every American's innate sense of fairness and justice, anyway.

Those are the happenings for this week, at least that we know about. If you have an accomplishment that you think should be listed, send us a note about it at mgreaney [at] cesj [dot] org, and we'll see that it gets into the next "issue." If you have a short (250-400 word) comment on a specific posting, please enter your comments in the blog — do not send them to us to post for you. All comments are moderated anyway, so we'll see it before it goes up.

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Own the Fed, Part XI: The Age of Regulation

Part and parcel of the change in the Federal Reserve under the New Deal was the enormous increase in government regulatory bodies, matched — or exceeded — only by the volume of new regulation and State intrusion into people's daily lives. What we find is that with the New Deal, the transformation of the Federal Reserve from what it was intended to be, to what it has become today was virtually complete. The central bank changed from an institution designed to operate in a manner consistent (for the most part) with Say's Law of Markets and the real bills doctrine, to one completely enmeshed in the misleading and false assumptions of the Currency School.

Fitting in perfectly with the assumptions of both the New Deal and the Keynesian economics on which the New Deal was based, the changes in the Federal Reserve extended and enhanced the economic as well as political role of the State. The process fixed in people's minds the belief that nothing could be done except by the State — the realization of Thomas Hobbes's totalitarian vision in Leviathan. This helped set the stage for today's almost complete functional overload of the State that the world is currently experiencing.

We examined some of the lesser-known new regulations of the Federal Reserve in the previous posting. In this posting we will take a look at three more widely known and, in one sense, more critical regulatory changes. Two of these were cut from the same cloth as the five measures we looked at in the previous posting, but the other was critical, one might even say an essential regulation, especially from the perspective of the Just Third Way: The Banking Act of 1933, more popularly known as "the Glass-Steagall Act" from the names of its co-sponsors, Carter Glass and Henry B. Steagall.

First, however, we need to look at the "bad" regulations, the Glass-Steagall Act of 1932 (referred to by Moulton as the "Glass-Borah law of 1932"), and the establishment of the Open Market Committee in 1935. Of the two, the establishment of the Open Market Committee caused the most damage; Glass-Steagall/Borah falls into a gray area: well-intentioned, but with unforeseen consequences. The 1932 Glass-Steagall Act (in contrast to the Banking Act of 1933) demonstrates the ease with which even the best-designed or well-intentioned institutions and laws can be corrupted and converted into doing exactly the opposite of what they were established to do.

True, the Federal Reserve System, for all it was and remains — at least in its original form — a work of genius and possibly the best-designed central banking system in the world, embodied some serious flaws. As we have seen, the powers-that-be were not slow to exploit these flaws when the opportunity arose. Whether this was out of malice or, more likely, out of the best of intentions, inspired by an honest desire to improve the institution but based on ignorance, is irrelevant. The process was carried out without reference to the laws and characteristics of social justice (cf. Rev. William J. Ferree, S.M., Ph.D., Introduction to Social Justice. Arlington, Virginia: Center for Economic and Social Justice, 1997), or to the precepts of the natural moral law embodied in, for example, the binary economics of Louis Kelso, particularly as explicated in the two books Kelso co-authored with Mortimer Adler (The Capitalist Manifesto, 1958; The New Capitalists, 1961) — especially the critical point highlighted in the subtitle of the second book, "A Proposal to Free Economic Growth from the Slavery of Savings."

Although this was clearly not the intent of the law, the 1932 Glass-Steagall/Borah Act substituted government securities for gold and commercial asset backing of the currency. This opened a way for the Federal Reserve to get out of the business of rediscounting private sector paper altogether. The law was promulgated in an effort to get out of the Keynesian "liquidity trap." As we recall from a previous posting, the Keynesian liquidity trap is an attempt to explain the failure of businesses to borrow, no matter how low the interest rate is set. According to Keynes, under certain conditions the demand for money becomes "infinitely elastic." Demand cannot be increased regardless how low the price.

The obvious flaw in Keynes's theory is that money and credit, neither one necessarily tied to the amount of savings already existing in the system, are not commodities. Not being commodities with a fixed quantity, money and credit will not behave in the manner of commodities and "obey" the laws of supply and demand. As Louis Kelso pointed out (and as we have previously noted), "money" is a measurement of wealth, necessarily tied to the wealth through the institution of private property, not wealth itself.

It is consequently foolish in the extreme to claim that derivatives of production — money and credit — cannot be matched exactly to the present value of existing and future marketable goods and services. The laws of supply and demand do not apply to money and credit. Keynes's liquidity trap theory is thereby invalidated. The reason businesses were not borrowing desperately needed financial capital from the banks is because they did not qualify as sound prospects, usually because of a complete lack of or unsatisfactory quality of the collateral offered.

Whatever the reason or reasons businesses were not borrowing, commercial banks were not issuing the commercial bills that qualified for rediscounting at the Federal Reserve. This resulted in a serious deflation of the money supply. This also caused a continuous decline in the inventories of commercial paper held by the regional Federal Reserve banks, which then had to back their note issues and demand deposits with gold.

Putting the cart before the horse, the authorities reasoned that if the insufficiency of commercial paper was causing deflation, a substitute was needed to back the money supply to counter the deflation. Thus, rather than figure out a substitute for the lack of collateral that was behind the "refusal" of private commercial banks to lend and the inability of businesses to borrow, Federal Reserve authorities requested permission to back new money with government securities, thereby freeing up gold and presumably countering the deflation that appeared to be at the root of the business downturn. As Moulton explained,

The continuous decline in the volume of commercial bills in the portfolios of the Federal Reserve banks necessarily meant that the Federal Reserve notes came increasingly to be backed by gold instead of by commercial paper. In 1932 the amount of Federal Reserve notes outstanding was approximately 2,900 million dollars, of which about two billions was secured by gold and 900 millions by eligible paper. The Glass-Borah law [Glass-Steagall Act] of 1932 authorized the Reserve system to substitute in place of gold as backing for Federal Reserve notes its holdings of government securities, to the extent of 740 million dollars. Thus 740 million dollars of gold was released and made available for open market operations, which were intended to check the deflation. As we shall later see, this operation was not successful in staying the course of the depression. It did, however, mark the end of the attempt to maintain an elastic bank note currency based on commercial paper assets. (Financial Organization and the Economic System, op. cit., 385.)

The effective closing of the discount window to private sector assets was followed a short time later in 1935 by the establishment of the Open Market Committee. As stated in the original Act, the primary business of the Federal Reserve banks was supposed to be creating money to purchase commercial paper presented by member banks for rediscounting. Obviously, being charged with regulating the money supply for the entire economy, there had to be some accommodation for non-member banks and other institutions that issued commercial paper. As such securities were on the "open market," each Federal Reserve bank was empowered to create money to purchase qualified industrial, commercial, and agricultural paper on the open market.

This ability to deal in secondary issuances — qualified securities offered on the secondary market — was only supposed to be a supplement to the Federal Reserve's power to rediscount primary issuances of member banks. As dealing in government securities began to assume greater and greater importance under the tenets of the Currency School, and the Federal Reserve was prohibited from monetizing government deficits by rediscounting primary issues of the federal government, open market operations involving the creation of money to purchase government securities began to supplement the System's stated principal purpose of rediscounting private sector primary issuances. As Moulton noted, "these open market operations in due course came to be regarded as a very important means of controlling the volume of credit." (Financial Organization and the Economic System, op. cit., 368.) As he continued,

Although the original Federal Reserve Act provided that such open market operations were subject to the "rules and regulations prescribed by the Federal Reserve Board," in actual practice Federal Reserve banks themselves, particularly the Federal Reserve Bank of New York, assumed the direction of these policies. The Federal Reserve Board made serious efforts over the years to regain its authority, and finally, in the Banking Act of 1935, an Open Market Committee was provided for. (Ibid.)

In other words, as the Federal Reserve abandoned its primary justification and its orientation in accordance with the real bills doctrine and Say's Law of Markets, it surrendered its ability to affect the quantity of money in the economy directly. It also found a way to embody in law what the framers of the original Federal Reserve Act had carefully designed the institution to avoid doing: acting as a source of financing for government expenditures, thereby circumventing the essential prohibition against monetizing government deficits.

The picture was not all dark, however. The "Glass-Steagall Act of 1933" — officially the Banking Act of 1933 — was also co-sponsored by Carter Glass. Glass was one of the prime movers in getting the original Federal Reserve Act of 1913 enacted, with the able assistance of President Woodrow Wilson and Wilson's Secretary of State, William Jennings Bryan.

The original act, however, had a serious flaw (more than one, as a matter of fact, but only one that concerns us at this point). That is, there was no effective means of preventing commercial banks from extending massive amounts of credit to their investment banking arms, thereby creating money to finance speculative or unsound flotations of securities.

To give some context, "commercial banking" consists of taking deposits, making loans, and issuing promissory notes. This last is the means whereby a commercial bank creates money backed by a lien on the assets so financed, with collateral added to secure the lender against the possibility of default on the part of the lender.

Investment banking, on the other hand, consists solely of acting as a financial intermediary between savers and investors. Investment banks are a type of deposit bank. That is, an investment bank extends credit out of its existing resources in order to purchase blocks of securities from issuing companies. It then turns around and sells the securities to investors. It cannot create money by issuing promissory notes as a commercial bank does. Instead, what an investment bank does is much closer to speculation than investment. Properly only a middleman, a financial intermediary, the temptation for an investment bank is often overwhelming to manipulate the values of the equity and debt in its inventory in order to make more than the profit to which it is entitled for the service it provides.

Reliance on existing accumulations of savings or having to go to an independent commercial bank presumably inhibits or prevents investment banks from accepting issuances that are too speculative or otherwise have too great a degree of risk — they are presumably more cautious and careful risking existing resources and loans for which they are on the hook than they would be when dealing with resources that they can, in a sense, create out of thin air. When commercial banking and investment banking are combined, however, the effect is to give free rein to people and institutions already inclined to gamble and engage in speculation. With direct access to the money creation powers of a commercial bank or even, in extraordinary circumstances, the central bank, an investment bank can, in effect, engage in margin purchases of questionable, risky, and speculative debt and equity issuances with a 0% margin, leveraging the purchase 100% on credit, and with no collateral other than the issuances themselves.

This appears to have been at least part of the reasoning of Henry Simons, founder of the "Chicago School" of economics — "the Monetarists" — and his proposal to implement a 100% reserve requirement. As proposed, the "Chicago Plan" would have prevented commercial banks from creating money for speculative purposes. It would, unfortunately, in a move that threw the baby out with the bath, also have prevented commercial banks from creating money for productive purposes as well.

Essentially, Henry Simons's idea, as summarized in his noted essay, "A Positive Program for Laissez Faire" (Henry C. Simons, Economic Policy for a Free Society. Chicago, Illinois: The University of Chicago Press, 1948, 62-63), was to eliminate commercial banking and transform all commercial banks into banks of deposit by prohibiting the issuance of promissory notes: "All institutions which maintain deposit liabilities and/or provide checking facilities (or any substitute therefore) shall maintain reserves of 100 per cent in cash and deposits with the Federal Reserve banks." (Ibid.)

The Federal Reserve's money creation powers would also be eliminated, except to purchase government bonds with which to back the currency it issued. The Federal Reserve would be unable to rediscount commercial paper or engage in open market operations. Instead, the Federal Reserve would be restricted to acting more or less in the capacity of a centralized national bank, more or less in accordance with the National Bank Act of 1864. The Federal Reserve would no longer be a central bank, per se. The Federal Reserve would ensure a uniform currency by acting as the federal government's principal depository and creating all new money backed by government debt.

The Federal Reserve would not, however, be able to function in the capacity of a true central bank by creating money to supply the private sector with liquidity in accordance with the real bills doctrine. The intent appears to have been to force the economy to rely entirely on existing accumulations of savings to finance capital formation, and restrict all new money creation to finance government expenditures.

The amount of money the government would be able to create through issuing new securities each year would be set by a "national Monetary Authority," with no other power than to determine the amount of new money that the government could safely create. To make certain that private sector monopolies and monopolistic industries were stripped of the power to manipulate the economy to their own advantage ("Eliminate all forms of monopolistic market power," ibid.), the rules under which the Monetary Authority operated would be "definite, intelligible, and inflexible" (ibid.), i.e., no appeal to a higher authority would be possible from the Authority's decisions.

Having seen the ease with which the Federal Reserve had been transformed from one sort of institution to another, however, Simons was also very concerned that the federal government as well as elements in the private sector be prevented from seizing control of the Monetary Authority. He was never able, however, to develop any system of checks and balances that would prevent the government from somehow manipulating the system to its own benefit. Simons ultimately refused to push for the implementation of his own proposal.

Simons's refusal to use his considerable prestige to push for the adoption of the Chicago Plan irritated such diverse individuals as Irving Fisher and Father Charles Coughlin, both of whom felt that the 100% reserve plan should be implemented immediately. Fisher believed that the proposal would the fastest way to "reflate" the currency and restore the price level. Coughlin believed such a move would break the presumed power of the Jews over the money supply. Fisher and Coughlin (among others) viewed Simons's concerns as needless scruples: people needed plentiful money and easy credit now. Control measures could wait; fix the problem first and worry later whether it was the best or even the right thing to do.

There was, however, a twofold problem that dwarfed even the extremely serious danger that the State would somehow be able to seize control of the Monetary Authority. That is, 1) forcing the private sector to rely exclusively on existing accumulations of savings for the financing of new capital formation, and 2) allowing the State to create money rather than be restricted to its proper role of setting the standard of value and regulating the currency as provided for in the Constitution would be an economic disaster.

Money is a derivative of production. Prohibiting the private sector from drawing bills on the present value of existing and future production of marketable goods and services, and preventing commercial banks from issuing promissory notes backed by such real bills would result in serious deflation. (Evidence suggests that at least two-thirds of GDP before the current Great Recession consists of transactions involving conveyances other than coin, currency, and demand deposits.) Restricting all new money creation for the purpose of purchasing government securities to serve as reserves backing the new money would mean that the private sector would be completely at the mercy of the State for the financial means to engage in industry, commerce, and agriculture. It would also undermine any effort at economic recovery, as Moulton explained in The Formation of Capital in his discussion of the dangers of cutting consumption in order to finance capital expansion. (The Formation of Capital, op. cit., 37-48.)

Glass-Steagall — the Banking Act of 1933 — while it did not manage to prevent commercial banks from being able to create money for speculative purposes, did institute a necessary "internal control" measure on the financial system: separation of incompatible functions. By forcing different types of financial institutions to separate, the Act cut investment banks (a type of deposit bank) off from commercial banks (a type of bank of issue), Glass-Steagall added a level of scrutiny between institutions that can create money, and institutions that can use the money to bid up the price of securities, thereby engaging in manipulation and speculation. As the summary provided by the Congressional Research Service of the Library of Congress and quoted on the Wikipedia (a very useful source when doing some basic research, as it directs you to primary sources) put it,

In the nineteenth and early twentieth centuries, bankers and brokers were sometimes indistinguishable. Then, in the Great Depression after 1929, Congress examined the mixing of the "commercial" and "investment" banking industries that occurred in the 1920s. Hearings revealed conflicts of interest and fraud in some banking institutions' securities activities. (http://digital.library.unt.edu/govdocs/crs/permalink/meta-crs-9065:1)

Glass-Steagall set up a "formidable barrier to the mixing of these activities." (Ibid.) Glass-Steagall also attempted to add a level of security for existing accumulations of savings, although not of the same character and effectiveness of a systemic internal control measure like separating incompatible functions. That was to establish the Federal Deposit Insurance Corporation, the "FDIC."

The Banking Act of 1933 was, all things considered, one of the most effective as well as necessary pieces of legislation to come out of the New Deal. It was not perfect, but it served to put in place an essential internal control feature that put the brakes on (or, at least, had the potential to slow the acceleration of) money creation for speculation instead of true investment. It did not eliminate the possibility of money creation for such purposes. The Act, however, did make money creation for such purposes more difficult by making certain that it would not be to the advantage of a commercial bank to misuse its money creation powers under most circumstances.

The problem with Glass-Steagall was not in the provisions of the Act itself. It could be argued that the Act did not, in fact, go far enough by managing to find a way to halt all market manipulation and speculation. The problem was that the Act straddled two incompatible approaches to understanding money, credit, and banking: the Currency School and the Banking School. Glass-Steagall addressed a few systemic changes that were necessarily limited in scope. It was not able to address the basic systemic problem of trying to reconcile mutually exclusive paradigms.

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